Taking to the Skies: Insurance-related Events in the Aviation Industry

Taking to the Skies: Insurance-related events in the aviation industry

June 2015    |    By Indrani Nadarajah

Every day, nine million passengers take to the skies on board nearly 100,000 flights. The overwhelming majority reach their destination safely. Flying is generally considered very safe, and for many years, the aviation sector experienced low claims.

However, 2014 was a difficult year for the industry because of the numerous significant claims: Malaysian Airlines MH370’s disappearance an hour after taking off (described by many observers as one of aviation’s greatest mysteries); the shooting down of another Malaysian Airlines plane over eastern Ukraine in July; the attacks on Libya’s international airport in Tripoli, where eight people were  killed and 12 planes damaged; the loss of an Air Algerie plane in Mali; the crash of a TransAsia Airways plane in Taiwan; and the AirAsia flight, which crashed into the sea off Indonesia in December, killing all on board.

This trend of high profile accidents carried forward into the first quarter of this year, when a suicidal pilot deliberately crashed a Germanwings plane into the French Alps, after locking another pilot out of the cockpit. The crash killed everyone on board.

Despite the high profile incidents, the year 2014 still turned out to be a very safe year for commercial aviation, Aviation Safety Network data show.

The Aviation Safety Network recorded a total of 21 fatal airliner accidents, resulting in 990 fatalities last year. Most accidents involved cargo flights (10) and passenger flights (8). Given the worldwide air traffic of 33 million flights, the accident rate is 1 fatal passenger flight accident per 4.125 million flights, the Aviation Safety Network calculated.

Aviation Industry Indemnity Act and War Risks Cover

The incidents mentioned above would trigger war risk provisions, which cover damage due to acts of war including invasion, rebellion and hijacking. As per Wikipedia, "war risk insurance usually has two components: War Risk Liability, which covers people and items inside the craft and is calculated based on the indemnity amount; and War Risk Hull, which covers the plane itself and is calculated based on the value of the craft."

According to Global Reinsurance, a global insurance magazine, the war risk aviation market's total premium is about US$70 million annually.

But the claims last year far outstripped the premiums collected. According to Lloyd’s, the  two Malaysian Airline incidents, fighting at Tripoli airport and other tragedies including an AirAsia plane crashing off the coast of Indonesia in December left it with £310 million of aviation claims - the most it faced in 14 years. There were also media reports that carriers were seeking to jack up the premiums of their war risks policies by 300% at the renewal season.

As the events after September 11, 2001 showed, the commercial insurance market cannot always be relied upon to provide war risks cover for the aviation sector.

To prepare for unexpected incidents where war risk insurance may not be available, Canada recently introduced the Aviation Industry Indemnity Act, which came into force on December 9, 2014.

Dave Dawson, Director, Airports and Air Navigation Services Policy, Department of Transport, said the Act would enable Canada's transport minister to regularly assess of the aviation war risk insurance markets and decide if an indemnity is necessary. The Act allows the government to indemnify insurance carriers and aviation firms against loss or damage, or liability for loss or damage, that is caused by an "event," which is defined as either "an act of unlawful interference with an aircraft, airport or air navigation facility, including an act of terrorism" or "an act or omission in the course of armed conflict, war, invasion, hostilities, civil war, revolution, rebellion, insurrection, an application of martial law, a usurpation or attempted usurpation of power, a civil commotion or a riot."

Major causes of losses in aviation

Plane crashes remain the major cause of loss for the aviation sector in terms of the number of insurance claims generated (23%) and their subsequent value (37%). Incidents involving planes over or under-shooting runways are ranked second according to value. Plane crashes are the third most expensive cause of loss for insurance businesses behind ship groundings and fire, according to an analysis of more than 11,000 major business claims by Allianz Global Corporate and Specialty Insurance (AGCS).

According to Allianz, about 18% of aviation claims relate to ground handling claims and 16% to mechanical failure. Aircraft are becoming far more complex - on average there are about 600,000 parts on an airline-type aircraft and this is causing a significant change in claims handling and costs, say industry experts. For example, the latest generation of aircraft are built using composite materials like carbon fibres enclosed in toughened resins. Such materials are stronger than traditional ones like aluminum. But such technology comes with a price - repairs can be more time-consuming and costly. They also require expert technicians, often in limited supply. Meanwhile, the cost of repairing older aircraft is increasing as older plane parts become more difficult to source.

More expensive and larger planes flying larger numbers of passengers has also contributed to the 50% plus hike in exposure since the turn of this century, from US$576 billion in 2000 to $896 billion in 2013. If exposure growth continues at the same rate, insurers can expect it to break through the $1 trillion barrier within the next five years, or possibly even sooner.

Capacity remains high

Aon’s 2014 Market Outlook reported that capacity continues to be high in the airline insurance market, totalling almost 230% for a non-US airline with a US$1.5 billion liability limit. Underwriters were attracted by the relatively low number of claims.

Despite the significant losses last year, the market was divided through loss experience as many insurers were not impacted directly by the Malaysian airline losses. (Allianz was the lead insurer for Malaysia Airlines.) Without a market-wide loss, any market hardening could not be both significant and sustained.

It was not surprising therefore that in its March 2015 report on the aviation sector, Willis observed that premium levels barely changed from the previous year. Premium increases in the final quarter were just 5%. Significant premium increases were not going to be achieved across the board when the majority of buyers approached their renewal with growing exposures, good loss experience and in the majority of cases a younger, safer fleet of aircraft.

The implications of Flight MH 370

On March 8, 2014, Malaysia Airlines flight MH370 left Kuala Lumpur bound for Beijing China with 239 passengers and crew on board. An hour later it vanished and has not been found to date. The total insurance loss of Malaysia Airlines flight is estimated at between US$500 million and $600 million. Malaysia Airlines has an overall liability policy with a cap of $2.25 billion for each crash, according to the New York Times.

The disappearance of the aircraft highlighted the issue of aircraft tracking.

In a world where it seems that Big Brother is constantly watching our very move, there was general disbelief that an aircraft could simply disappear without a trace. The International Civil Aviation Organization (ICAO), a United Nations body that regulates global aviation, proposed, after MH370, that commercial aircraft report their position every 15 minutes instead of the current norm of between 30 and 40 minutes. This would improve the ability to track commercial aircraft globally and find remote crash sites much faster.

Technology called space-based ADS-B (Automatic Dependent Surveillance – Broadcast) helps an aircraft determine its position via satellite navigation and periodically broadcasts it, enabling it to be tracked. The information can be received air traffic control ground stations as a replacement for secondary radar. It can also be received by other aircraft to provide situational awareness to the pilots.

ADS–B is "automatic" in that it requires no pilot or external input and is "dependent" in that it depends on data from the aircraft's navigation system. Canada already employs this technology. ADS–B equipment is also mandatory in parts of Australian airspace. The United States requires some aircraft be equipped by 2020. The equipment will be mandatory for certain aircraft in Europe beginning in 2017.

Emerging Risks

Drones

The use of flying robotics in the form of small unmanned aircraft systems (UAS), or drones, is predicted to significantly increase over the next 10 years. The US’s Federal Aviation Administration (FAA) has determined that small UAS are “currently the most dynamic growth sector within the aviation industry.” By 2020, it is estimated that about 30,000 small unmanned aircrafts will be used for various business purposes. The FAA has allocated US$63.4 billion for the modernization of the country’s air traffic control systems as well as an expansion of airspace to accommodate the commercial use of UAS.

Total spending for small unmanned aircraft systems worldwide is expected to reach US$89.1 billion over the next 10 years.

One estimate shows annual spending on commercial and military drones will reach US$11.6 billion by 2023. In the US alone the design, manufacture and operation of drones could create up to 70,000 new jobs.

Drone use in Canada

Canada has allowed the use of commercial drones since 2007, and drone use here has been largely uncontroversial. Commercial drone use in Canada is regulated on a federal level by Transport Canada, governed by Canadian Aviation Regulations.

A Special Flight Operation Certificate (SFOC) must be secured from Transport Canada before operating a commercial drone in Canada. A commercial operator must also have $100,000 of liability insurance in place regardless of drone size and use. More than 940 SFOCs for commercial drone use were approved in 2013 by Transport Canada, up 500% from 2011, when 155 certificates were issued.

The drone industry is in its infancy and the property and casualty industry's understanding of this emerging risk continues to evolve. Industry pundits believe that current insurance contracts may be inadequate to address all of the issues posed by this evolving technology. Conventional insurance coverage may have to be re-crafted in order to provide meaningful and sustainable coverage for the consuming public.

There are several broad areas of risk involved with the use of drones:

One is that drones have only a limited capability of detecting problems - either via camera and other sensing devices placed on board; this limitation is further defined by the amount and speed of the data that it is able to transmit to its ground-based controller. “These are far short of what a pilot on board an aircraft can detect and respond to,” an AM Best briefing warned.

A second type of risk is operator error, “whether due to inadequate training or operating mistakes stemming from shortcomings in the data transmissions from the drone.” A third risk is loss of communications with the drone during active operation. This could be caused by equipment failure, drone distance exceeding the radio transmission range, weather interference, or more maliciously, usurpation of control by unauthorized individuals, A.M. Best suggested.

Toxic air in cabins

Around half the air on board most modern commercial jets is drawn through the plane’s engines and this could be creating expensive headaches for some airlines.

British airlines, which have not yet been identified, are facing “toxic air” claims by 17 former and current cabin crew. The claimants say they have been poisoned by inhaling toxic fumes while on the job. The cases are being funded by the Unite union which represents 20,000 flight staff in the UK.

The BBC reported that workers believe they became sick after breathing in fumes mixed with engine oil and other toxic chemicals. Campaigners say when a fault occurs in the engine seals, potentially poisonous gases can be released and reach the cabin. This includes TCP, an organophosphate that is dangerous to human health in high enough quantities. The problems can affect the central nervous system and brain.

The Civil Aviation Authority says there is no evidence that chemicals appear at high enough concentrations to cause harm.

Greater air turbulence

Scientists also predict that turbulence will increase in the North Atlantic flight corridor in future due to the changing climate. A report published in the journal Nature Climate Change predicts that one effect of a warming planet is that international flights will get more turbulent by the middle of this century. Turbulence during transatlantic flights will occur with greater frequency and intensity if carbon dioxide emissions double by 2050 as the International Energy Agency forecasts.

The chances of encountering significant turbulence would increase by between 40% and 170% on the North Atlantic flight corridor, where 600 jets travel between Europe and North America each day, by the middle of the century. Light turbulence shakes the aircraft, but s turbulence can injure or kill passengers, and in some cases, damage planes.

In 1992, severe turbulence ripped an engine of a DC-8 cargo aircraft flying out of Denver.

Pilot and technician shortage

The 2014 Boeing Pilot and Technician Outlook projects that 533,000 new commercial airline pilots and 584,000 new maintenance technicians will be needed to fly and maintain the world fleet over the next 20 years. Over the next 20 years, the Asia Pacific region, with a requirement for 216,000 new pilots, will see the largest growth in pilot demand.

By 2033, approximately 48% of global traffic will be to, from, or within the Asia Pacific region. As a result, the region will also need 13,460 new airplanes, valued at US$2 billion.

Over the same timeframe, Europe will require 94,000 pilots; North America, 88,000; the Middle East, 55,000; Latin America, 45,000; the Commonwealth of Independent States (CIS), 18,000; and Africa, 17,000.

The need for technicians will also remain high. Global fleet growth, combined with the increasing trend to outsource maintenance, repair, and overhaul activities to third-party providers in emerging markets will drive the need for qualified personnel.The need for maintenance personnel is greatest in the Asia Pacific region, which will require 224,000 new technical personnel. Airlines in Europe will require 102,000; North America, 109,000; the Middle East, 62,000; Latin America, 44,000; the CIS, 24,000; and Africa, 19,000.

Montreal Convention 1999

One significant factor that dogs the aviation sector is the uneven patchwork of liability regimes globally. Some countries have signed up to the Montreal Convention, which came into force in 2003. The Montreal Convention 1999 (MC99) establishes airline liability in the case of death, injury or delay to passengers, baggage and cargo. It is designed to be a single, universal treaty to govern airline liability around the world.

To date, only 110 of the 191 International Civil Aviation Organization-contracting states, are parties to it. A number of fast-growing aviation markets in Asia like the Philippines, Indonesia, and Vietnam, have yet to sign up. Russia is another absentee. Few African countries have also adopted MC99.

Some countries still abide by the older Warsaw Convention, (1929) the Hague Protocol (1955), or the Guadalajara Convention 1961. Some, like Thailand have not signed up to any international convention.

Uneven liability caps create unnecessary heartache and sometimes, prolonged litigation, for victims’ families.

On January 29, 2015, Malaysia formally declared flight MH370 “an accident” opening the way for the airline to compensate the families of victims. Article 17 of the Montreal Convention states: “The carrier is liable for damage sustained in case of death or bodily injury of a passenger upon condition only that the accident which caused the death or injury took place on board the aircraft.”

Malaysia said it was ready to proceed immediately with the compensation process, but that process has been fraught with delays and disagreements. Media reports state that only seven families have accepted US$50,000 payments. (The Montreal Convention states that the next of kin is entitled to US$176,000 for each victim that perished.)

On the other hand, relatives of victims of the TransAsia flight which crashed in Taiwan last July were reportedly offered US$473,000 for each person killed.

When the Germanwings plane crashed, the insurance consortium led by Allianz subsidiary Allianz Global Corporate & Specialty (AGCS), set up reserves of $300 million to cover the loss. Experts expect the claims to amount to between one and two million euro (C$1.4 to $2.8 million) per passenger killed. Given that all 150 passengers and crew lost their lives this would amount to an insured loss in excess of €150 million (C$210 million).

The 38th Assembly of the International Civil Aviation Organization that took place in 2013 adopted Resolution A38-20, urging all States that have not done so to ratify MC99 as soon as possible. IATA acknowledges that countries fail to adopt MC99 because of “political inertia or political volatility.” MC99 can also require changing local or national laws, which can be a time-consuming process.

ADVANTAGE Monthly trends papers

This paper is part of an open online library of ADVANTAGE Monthly trends papers, published by the CIP Society for the benefit of its members and of the p&c insurance industry. The trends papers provide a detailed analysis of emerging trends and issues, include context and impact, and commentary from experts in the field.

The CIP Society represents more than 18,000 graduates of the Insurance Institute’s Fellowship (FCIP) and Chartered Insurance Professional (CIP) programs. As the professionals’ division of the Insurance Institute of Canada, the Society’s mission is to advance the education, experience, ethics and excellence of our members. The Society provides a number of programs that promote the CIP and FCIP designations, continuous professional development, professional ethics, mentoring, national leaderships awards, and research on the issues impacting the p&c insurance industry in Canada.